Cconsider the the following riddle. In 2021, venture capitalists raised $150 billion in fresh money, a record amount. Despite a market slowdown, they broke the record again in 2022, raising more than $160 billion. Much of it has already been spent, but nearly $300 billion in “dry powder” is waiting to be deployed. In fact, spending declined throughout 2022. Start-ups appear cheap. So why are venture capitalists sitting on the till?
As with many other financial mysteries, the answer begins with the rapid rise in global interest rates since early last year. Higher interest rates have caused stocks to fall in value as investors reallocated capital to safer assets such as cash and government bonds. The techie Nasdaq The index has lost more than a fifth of its value in the past year. In 2022, the amount of capital raised in IPOs fell to a 32-year low. Public market slowdowns, such as those currently occurring, reduce the expected returns for investors in private markets by lowering the valuation at which startups “exit” public markets. Venture capitalists therefore charge lower prices to invest at all.
This is particularly detrimental to the financing of late-stage startups, which in normal times could be on the verge of an IPO. Some companies, showered with fundraising monies in 2021, are choosing to wait things out and slow the pace of new deals. The smaller number, who are going ahead with plans, must hope to avoid a dreaded “round down,” in which a startup raises money at a lower valuation than a previous round — a disappointment for employees and early investors who are forced to take losses in purchase to take their shares. Meanwhile, investors are less willing to bet on riskier opportunities. They can no longer rely on another supporter to follow them to a store and contribute either expertise or hard cash to its success.
The second part of the answer is more subtle. In theory, venture capitalists could spend whatever money they have on hand. It is, after all, already committed to their means. For some companies, this would mean that they would also avoid losing out on management fees, which after a certain period of time only apply to the capital invested and are not tied to just their funds.
But spending at a breakneck pace would almost certainly prove self-defeating in the long run. Venture capitalists regularly raise money from limited partners such as foundations and pension funds. Many of them are now looking to reduce their exposure to venture capital as public markets have been hit and they are trying to keep allocations across asset classes roughly balanced. As a result, a handful of venture capital funds are calling to say things that say “don’t rush back” to get more money, says an investor in several venture capital funds.
Venture capitalists are listening. Harry Nelis, a partner at Accel, a venture capital firm, speculates that cash that may have taken a year to issue during the market boom will now last about three times as long. And spending could slow down even further. The money raised by venture capital funds isn’t actually in their bank accounts. Instead, funds must make “capital calls” on their limited partners if they want to fund an investment. This forces the limited partner to release cash elsewhere in their portfolio, which they are reluctant to do during times of stress. The funds are aware that they may want to return to their partners for more money in the future, so try not to irritate them by making calls at inconvenient times. Indeed, in 2001, during a post-dot-com slowdown, some investors “give back” committed funds to limited partners so their partners could redistribute the money as they wished.
Venture capitalists have other reasons to worry about limited partner relationships. During the recent boom, funds began to poke their noses far beyond their usual worries. Sequoia Capital, a famous Silicon Valley company, has launched a “superfund” that includes investments ranging from traditional venture capital investments to public market stocks. Some limited partners thought such funds were absurdly broad, but bought in anyway in order to gain access to special funds. No wonder venture capitalists are now taking pauses and trying to mend relationships with their limited partners. At least as long as market conditions remain miserable, the industry’s world-conquering ambitions will remain on hold. ■
